Having just managed to crawl out of a two year recession, the Irish economy was recently branded the sickest of all advanced nations by the IMF.

And despite the Fund making noises that Ireland will not default on its debt, its credit rating has just been downgraded regardless.
As the New Statesman’s Mehdi Hasan put it:

Ireland, of course, cut like crazy to appease the gods of the bond markets but evidently it didn’t work out for them. Please note Mr Osborne.

But the Lib Dems need to look in the mirror too.

That Ireland has just had its rating cut blows away the fig leaf which has so far been covering the ConDem cuts: that severe retrenchment of public finances is essential if Britain isn’t to lose its AAA credit rating and see the cost of borrowing soar in the long term.

This talk was always highly dubious in itself – not least because Britain’s situation was always far healthier than Ireland’s (or Greece’s) – but it now looks ridiculous. Plus there is the very real risk that cutting too hard and too soon will cripple economic recovery.

Yet all we’ve had out of the Lib Dems is a front bench minister resign over financial impropriety, and a welcome but ultimately timid and non-committal suggestion of a graduate tax. In truth, you’d be hard pressed to know this was coalition government at all.

The downgrading of Ireland’s credit rating should now serve as a moment of reflection for the Lib Dems regarding their future path. I see three options:

Use greater influence within the coalition to rein-in the Tories

Quit the coalition and have no more to do with the Conservative assault on public finances

Remain in the coalition and continue to facilitate the Tory programme.

Option 1 looks an obvious non-starter; as junior partners the Lib Dems appear to exercise virtually no significant influence over the Tories.

The problem with 2, of course, is that whilst it might be highly principled the Tories will quickly accuse the Lib Dems of destabilising the country. They will then have a good chance of returning a Conservative majority in a fresh election which the Lib Dems (and Labour) probably can’t afford to fight anyway.

But as for 3, the long-term risk is that when the Tory cuts really start to bite the Lib Dems will take the flak as the enablers of a vicious programme which hurts ordinary people’s lives.

So although Ireland should be a prompt for Lib Dem soul-searching about the bed they’ve chosen to make, whether or not they continue to lie in it may end the same: that they are held accountable for making possible a political programme of pain that wasn’t even their own.

Reader comments

1. The government’s gradual but significant loss of financial strength, as reflected by the substantial increase in the debt-to-GDP ratio and weakening debt affordability (as represented by interest payment to government revenue).

2. Ireland’s weakened growth prospects as a result of the severe downturn in the financial services and real estate sectors and an ongoing contraction in private sector credit.

3. The crystallization of contingent liabilities from the banking system, as represented by a series of recapitalization measures and the need to create the National Asset Management Agency (NAMA), a government-created special purpose vehicle that is acquiring impaired loans from banks.

So, that’s the increased proportions of interest payments to Govt revenue, the collapse in the banking and construction sectors and a series of specific payments to AIB and the creation of a Bad Bank. Do you see anything there that would be improved by a larger deficit? Are you suggesting that Government spending could turn around the construction sector, given that there are literally thousands of surplus builds both residential and commercial in Ireland?

That Ireland has just had its rating cut blows away the fig leaf which has so far been covering the ConDem cuts: that severe retrenchment of public finances is essential if Britain isn’t to lose its AAA credit rating and see the cost of borrowing soar in the long term.

It really doesn’t. That proposition may or may not be the case for the UK, but Ireland’s credit rating downgrades – this one and the one in 2009 – have been driven by the extremely large costs of recapitalising AIB. It’s no more apposite than pointing to Greece as being what happens if deficits are allowed to spiral.

I broadly agree with this, Paul. I also think Option 1 is the best but very difficult, if not impossible the ratio of Tory to Lib Dem MPs is just over 5:1. The problem is that they had no viable option after the election other than to join the Tories in government – had they let the Tories run a minority government, they’d have been accused of destabilising the country, and been painted as eternal losers, destined to never be in power.

I think you’re not being entirely fair about their influence – the Coalition is outflanking Labour on the left in numerous areas, and Labour is now barking at them from the right.

The latest downgrades were pretty much priced in so they don’t have the same impact on yields as the initial downgrades. For example, they sold 1.5 billion euros this morning with a bid-to-cover ratio of 3.6 (3.1 in June). Those are healthy ratios. I think the point Paul is making in the UK context is the argument that we need severe austerity now to stop yields going through the roof is bollocks. Gilt yields have fallen since the budget in the UK is an unhealthy sign. Money is flowing out of risk assets to the safety of the bond market because growth will be lower with austerity. See Cable & Wireless down double digits today because profits will be lower through austerity. If growth is lower, tax receipts are lower, which can quickly lead to deficit tail chasing.

bond yields are hard to interpret. people need to hold some sort of asset. even if you believed that the US and UK government are likely to default (that is, not literally default, but inflate away their debt by printing money) interest rates on bonds could still be very low because every other asset class is even less attractive. If you don’t want to hold advanced economy debt, what else is there? canned goods and ammunition?. I have no idea what would happen to UK bonds should a more attractive asset class emerge, or how likely that is.

if you really wanted to think about how much debt to accumulate, you wouldn’t just be looking at interest rates now, you’d be thinking about the future costs of rolling-over or repaying that debt, including the costs of inflating it away, and how that compares to the current benefits of deficit spending. Lord knows how you do that.

Can someone impartial and knowledgable please explain to me how the credit rating agencies obtain their power and who chose them to do the job? It seems from a layman perspective they have a disproportionate ability to pull down economies (much like the unelected and unaccountable IMF).

6 – With regard to sovereign debt in particular the Credit Rating Agencies reflect the market far more than they set it. That’s why there usually isn’t a dramatic market reaction to sovereign downgrades – the move has already been priced into the market.

The new mantra of the British left is that there is no problem for which the solution isn’t borrow more. Then more. Then some more.

That’s hardly true. There is pretty much only one thing a real-world, non-whelk-stall attitude to debt is useful for: arguing against those people who want to commit economic suicide out of some kind of sense of shame or duty.

Opposing that is hardly restricted to the left: not everyone is down on the ground shouting ‘jump’. Not least because we are the ones who will have to clean up the splatter.

What is it with people and the IMF? I mean I’m very ready to accept that the IMF hasn’t been a very good doctor, but why do so many people blame the doctor for the disease? The IMF shows up after an economy has collapsed.

as for credit rating agencies, you could imaging a world with no credit rating agencies, in which people who buy debt (lend money) have to estimated the probability of default for themselves. All that’s happened is that investors (lenders) have outsourced that research to some agencies, and then some of them have bound themselves to some rules where they have to do what the agencies say. Obviously this can lead to trouble if the people lenders have delegated the task of quantifying credit risk to do a bad job, but they are not some all powerful entity – lenders are quite free to do their own research, ignore the agencies, and those who have bound themselves (by, saying, following a rule to invest a fixed percentage of their money in AAA rated debt) could cut their binds, if they wanted to.

The problem, as I’m sure you know, is the shock treatment the IMF proscribes to economies that are collapsing/have collapsed. For example, the Hungarian forint has fallen against the Euro because the IMF said it isn’t cutting enough.

because usually the doctor prescribes a placebo for the economy that has the side effect of destroying spending on social programmes and removing regulations that prevent corporations dumping toxic waste on rural communities.

But why not in Ireland’s case, then? The article says that Ireland “cut like crazy” to appease the markets and the IMF supported it, but it still had its credit rating cut?

It’s the wrong question really. Ireland had a budget deficit of over 12%, and its economy was heavily reliant on two sectors – construction and banking – that were disproportionately hit by the financial crisis. In order to get its budget into something like balance, and avoid the sort of spiral that destroyed Greece, Ireland needed to cut pretty hard.

But the long-term prognosis for the economy is moderate at best – apart from anything else because it’s still not clear to what extent AIB will need further bail-outs. As a result, investors are less happy buying Irish debt than they are buying German debt – there’s a spread of 293 points between them, which only widened by 10 points after the downgrade.

The question that should be asked is ‘what would the Irish rating be if they had ‘increased their fiscal stimulus’ by borrowing more to chase growth? Greece’s rating is now junk – BBB. Ireland is AA.

[…] is no guarantee that economic austerity will lead to better economic confidence and performance, as the Irish experience shows. Perhaps, as the current Hungarian experience suggests, economic rectitude does not have to mean […]